Continuing a trend of Apple (AAPL) price target increases, Credit Suisse’s Kulbinder Garcha today reiterates a Neutral rating on the shares and raises his price target to $96 from $85.71, writing that the company’s services are leading to an “enviable portfolio of iServices.”

Apple shares are up 11 cents at $90.39.

Garcha thinks the offerings “combined with its multi-product compute offering, creates a sustainable competitive advantage” and will allow the company “an annuity stream from its valuable 800mn installed base.”

Garcha thinks the most immediate change is that Apple will move heavily to subscription-based music with the recent acquisitions of Beats.

Writes Garcha, the conventional wisdom about the music industry is wrong because “Conventional investor wisdom says that the owners of music content IP (record labels and music publishers) have many years of migration from physical to digital formats in front of them, and are unable to control the economics of digital distribution because they lack market power versus Apple.”

In fact, though, “We think a major change in music consumption is under way, which will up-end this view, namely due to the emergence of music subscription services.”

Rather than being disrupted, Garcha expects Apple to grab hold of the streaming music trend, bundling it with its devices:

We believe Apple is likely to further accelerate the music subscription market’s development via its recent purchase of Beats Music. Apple has an iTunes installed base of around 800mn users – providing a global distribution platform and, crucially, a virtually frictionless payment system. It seems logical then to expect Apple to include Beats Music in a software upgrade to its entire global installed base, and/or bundle a free/discounted subscription for a fixed period with new hardware at the point of sale. We would regard both of these developments positively for the whole industry. With iTunes stores in 123 countries, 425 retail stores, App stores in 155 countries and an army of 800mn users, Apple could very quickly scale a music streaming service, given its existing reach and music deals. Indeed, while the iTunes Music contribution alone is a relatively small percentage of their revenues by our estimates, we believe its long relationship and the usage of music in its products remains a core feature set, and is an area where the company will remain committed [...] We forecast music subscription services can grow from 14mn paying subscribers in 2013 to just over 148mn by 2025, with penetration of adult populations (15-64 years) rising from 5% to 20% of in each of the 10 major music markets in the world. Penetration levels would still be significantly lower than for pay TV subscription in developed markets, and just 7% of global smartphone penetration. We highlight the examples of Sweden and Norway, where penetration of music subscription services has already reached 19-24% of music revenue.

Garcha goes on to suggest Apple has greater integration than Google‘s (GOOGL) Android between its various services and its devices:

Apple has built an entire portfolio of services. Apple has built a portfolio of services that range from the App Store, iMessage, iCloud, iBook store and now HomeKit and HealthKit. Additionally, these services are increasingly integrated across its major hardware portfolio of Mac, iPhone and iPad. We believe that Apple’s vertically integrated structure across hardware, software and services, and across multiple products results in several strategic advantages versus its peers. First, it leads to high quality levels of integration in a manner that we argue rival platforms such as Android and Windows lack. Second, seamless availability of services and software competency results in high levels of usage (whether looking at mobile browsing, mobile commerce, or data usage, iOS devices materially outperform their installed base of smartphone units by a factor of four) which makes the company an attractive partner for new ecosystems. Third, given many of Apple devices cover all aspects of its consumer’s lives from TV consumption to mobile telephony to PC’s, the company owns a Big Data advantage that few of competitors have, which we believe is useful for new businesses and product improvement. Finally, it provides a platform for new services and products ahead.

That, argues Garcha, has led to a “an annuity based hardware business model” where people keep coming back to the hardware products because they like, or feel trapped in, the “ecosystem”:

Perhaps the most important aspect of Apple services innovation over the past decade is that the above results in record levels of customer satisfaction and retention rates close to 90%. Additionally, while monetizing many of these services is not Apple’s primary objective, it does allow the company to premium price. We would argue that whether it is the customer lock-in and essential headache of leaving iOS ecosystem or the loyalty, the output is the same, meaning that once an individual or family is part of the Apple ecosystem, they will very rarely leave it.

Garcha does some back-of-the-envelope math for how much that lock-in, and the annuities it creates, is worth to the company, including a dramatic rise in iTunes user accounts to 1.3 billion in three years: (click for larger image):

Goldman Sachs’s Bill Shope today reiterates a Buy rating on shares of Apple (AAPL), and raises his price target to $720 from $635, writing that the company’s upcoming Worldwide Developer Conference in San Francisco, starting Monday, may bring important additions to the company’s software and services, which, more than hardware, are “The Next Big Thing” for the company, he believes.

Don’t get too preoccupied with hardware alone, he urges:

While upcoming hardware refreshes (i.e., iPhone 6 and TouchID-enabled iPads) are likely to serve as powerful near-term drivers of Apple’s earnings momentum and stock price, platform enhancements such as mobile payments, connected home solutions, and personal health monitors should be far more important for driving switching costs and installed base expansion over time, and this is what will determine if Apple’s cash flow generation can remain robust and substantially increase from current levels.

Shope highlights his expectations for WWDC topics:

We believe the event will be centered on Mac and iOS software refreshes, iOS platform enhancements, with some minor Mac refreshes being the only hardware-centered announcements. More specifically, we believe it is likely that we will see (1) iOS 8 preview and beta release; (2) the next version of OS X for the Mac, with a beta release; (3) Internet of Things sub-platforms (likely related to personal health and the connected home); (4) standard Mac refreshes; and (5) a more detailed discussion of the recent Beats acquisition. Meanwhile, we believe it is possible, though less likely, we will see (1) enhanced third-party app support for Siri and (2) third-party support for TouchID commerce APIs.

More important, to Shope, is his “framework” for thinking about software and services.

He declares Apple “rarely rests on its platform laurels,” and attempts to show how successive services — iTunes, then App Store — have helped the company maintain loyalty to its hardware devices:

As smartphones and tablets have subsumed once stand-alone categories of compute, portable media players, and mobile telephony, they have also become hubs for the various sources of platform value these categories depended on. Apple’s evolution as a company has been partially shaped by this process over the past decade: (1) the iPod platform was intricately dependent upon media content, with iTunes representing the primary delivery mechanism for this content; (2) the smartphone subsumed this functionality, and Apple was able to link-and-leverage its iTunes dominance to give the iPhone a head start in this burgeoning market opportunity; (3) with the emergence of the App Store and bite-sized, mobile-centric apps, iPhones began to capture the personal compute functionality once reserved for Macs and PCs; and (4) the iPad took this to the next level, abruptly changing the personal computing industry landscape. Apple’s rapid growth also tightly followed this evolving industry narrative (Exhibits 3 and 4).

Here is Shope’s chart of how App Store took over from iTunes just as non-DRM music was eroding the lock-in of iTunes:

As for what’s next, Shope writes a kind of map of the Apple ecosystem:

The concentric circles in the exhibit below contain three levels, with the operating system at the core. On the outermost level, are what we view as eight viable sources of switching costs and customer value for mobile ecosystems. In the middle layer, we illustrate the mechanism that ties the core to the switching costs. For example, for entertainment media to become a source of platform stickiness, the ecosystem needs to have content deals in place (e.g., with record labels, film studios) and a consumption mechanism. In Apple’s case, iTunes and the iTunes Music Store have served that purpose. Similarly, the iOS software development kit (SDK), developer tools, and the App Store were what made iOS a capable platform for mobile compute. By the same token, we saw iCloud and Siri as gateways to new switching costs related to user-generated content (e.g., Photo Stream, iWork for iCloud, syncing of contacts and calendars) and search more generally. But for iCloud and Siri to truly enhance the platform, they need to substantially distinguish themselves from existing competitors, which in our view has not happened yet. We also see several potential sources of switching costs where Apple has barely scratched the surface, for example social networking, payments, and physical monitors (e.g., iWatch). Although we would be encouraged by developments in these areas, we believe it is important to remember that these should be primarily platform enhancements rather than revenue replacements. It would clearly be a mistake to underestimate Apple’s ability to innovate and succeed in some of these opportunities for platform enhancement. With that said, Siri and iCloud have taught us that not all innovations can provide Apple with substantial differentiation. In addition, with a rapid pace of innovation from competitors such as Google, Apple now faces a larger hurdle than it did with its iTunes and App Store launches. Nevertheless, innovations in areas like mobile payments and personal monitors (Internet of Things more broadly) could begin to reinvigorate Apple’s platform differentiation and stimulate overall device growth.

Shares of Apple (AAPL) are up $12.19, or 2%, at $636.20, and earlier hit a new 52-week high of $636.87, as the Street responds to yesterday’s announcement the company will purchase music startup Beats for $3 billion, and as the Street prepares itself for Monday morning’s keynote address by CEO Tim Cook and staff at the company’s Worldwide Developer Conference in San Francisco.

Most analysts today acknowledge the Beats deal itself, while the biggest in Apple’s history, is relatively small given Apple’s enormous cash flow and already substantial cash pile.

As BMO Capital Markets’s Keith Bachman wrote in a note to clients, “Apple has around $133 billion of total cash, and we forecast around $48-50 billion of free cash flow in both FY2014 and FY2015.”

“Hence, the acquisition represents around 2% of its cash balance and 6% of free cash flows.”

There have been a few more price target increases today following those yesterday from Bernstein Research and Barclays.

UBS’s Steve Millunovich reiterated a Buy rating, and raised his price target to $700 from $625 after raising his iPhone unit sales estimate for the December quarter to 56 million from 54 million, which boosts his EPS to $48.09 from $47.77. Milunovich is “increasingly confident that iPhone sales in the US should benefit from a significant upgrade cycle late this year.”

He draws on data from organization YouGov.com:

Survey data from YouGov.com suggests that more than 50% of current US iPhone users are due for an upgrade over the next ten months (Figures 1-3). The sample of about 7,500 excludes those with prepaid plans. About 30% of users currently are off- contract or have contracts expiring within the next five months, and 20% have contracts expiring in the next 6-11 months. By model, just over 50% have an iPhone 4 or 4s and 30% have the iPhone 5.

Millunovich thinks WWDC is part of Apple regaining an image of innovating:

Investor sentiment has been somewhat apathetic as reflected by two-thirds of funds owning Apple being underweight. That view may change starting next week. We don’t expect much new hardware at WWDC but software enhancements and discussion of the Beats Electronics deal are likely. Along with two iPhone 6 models, the first wearable might be introduced later this year. The point is that innovation is not dead. Jony Ive has said, “We are at the beginning of a remarkable time, when a number of products will be developed…we’re not even close to any kind of limit.”

The Beats deal is “defensive,” he writes, in streaming music. But Apple also gains a negotiating talent with Jimmy Iovine, the Beats co-founder:

Apple touts Beats as best in class with a combination of algorithmic and human curation that is the future. This can be viewed as a defensive move given weakness in iTunes downloads. Catching up to Spotify and Pandora is a tall order; Apple may have concluded that it needed a separate brand and approach [...] Beats founders Jimmy Iovine and Dr. Dre will join Apple. Iovine will be full-time and has cut his ties with his music company. One of the many things lost with Jobs’ passing was his negotiating skills, where Iovine can make a difference on the music side. Finally, Apple expects to boost the visibility and distribution of Beats headphones though it has not decided how branding will be handled. It finally makes an accessory for the iPhone.

Piper Jaffray‘s Gene Munster reiterates an Overweight rating today, and raises his price target to $732 from $640, writing that discussion of a fitness application at WWDC “would be a significant sign pointing to an Apple watch/band in 2H 2014″ while discussion of the next version of Apple’s iOS, version 8 might include discussion “of software elements that point to a larger screen device.”

“While neither of those products would be a surprise, we believe increasing news could move shares of AAPL higher over the next few months,” he concludes.

Munster is also expecting a possible refresh of the Macbook laptop line, “most likely an [Macbook] Air with Retina display or spec bumps to the Macbook Pro line,” although he notes that Apple “recently (late April) updated its Macbook Air line-up with faster processors and a new $899 starting price (from $999).”

Munster also notes a Financial Times article that appeared Monday suggesting some discussion at the conference of Apple getting into the “connected home” market. Apple, he writes, is “a significant indirect player given that many automated home users utilize iOS devices to control the home.”

“We note that the most likely update at WWDC could be a software preview that shows Apple offering a single app to manage an entire home.”

R.W. Baird’s Will Power reiterates an Outperform rating on Apple shares, and raises his price target to $665 from $620, writing that “the acquisition raises a number of strategic questions, but foremost providers new talent and a subscription streaming music service that could help Apple regain its leadership in digital music.”

The deal may stem a decline at iTunes, and also brings talent and patents to Apple:

Notably, iTunes momentum has waned in recent years, due in part to the rise of Spotify and Pandora. Apple’s iTunes Radio, its attempt at a Pandora-like service, has seemingly failed to make much of a splash as of yet. The Beats Music streaming service could provide Apple a needed boost to regain its market-leading position in digital music [...] We generally view the additions of Jimmy Iovine and Dr. Dre to the Apple executive team as a positive infusion of music industry talent [...] Technology portfolio light. We would note that the recently launched Beats Music streaming service is reported to have a mere ~250,000 subscribers and only has two awarded patents. Beats Electronics has 20 awarded patents, most of which are for ornamental design, vs. Harman’s 868 patents and Bose’s 558.

Bill Shope of Goldman Sachs, reiterating a Buy rating, and a $635 price target, writes that the Beats deal “potentially represents an important strategic shift” for the company:

(1) it signals that Apple is becoming more acquisitive and is now willing to purchase larger assets and (2) it suggests that Apple is becoming far more aggressive in monetizing peripheral services and accessories that attach to its iOS installed base. Both of these factors are strategic positives, in our opinion, although it is strategically surprising to us that Apple’s first major move is to purchase a primarily brand-centric hardware company as opposed to a pure services, content, or software-centric asset. With that said, the Beats Music asset adds subscription music to iTunes, and this could become an increasingly important platform enhancement over time.

Rod Hall at J.P. Morgan maintains an Overweight rating on Apple shares, writing that he thinks the company might dump one of the two companies it is picking up, the headphone maker Beats Electronics, while retaining the Beats Music portion:

We find it hard to see how Apple juxtapositions the Beats Electronics branded headphones with its own brand. We also found it interesting that Apple’s press release lists Beats Music first and the electronics brand second even though we believe most of the current revenue is associated with the electronics. We believe that the iconic Beats Electronics headphones and accessories business would easily stand on its own. As a result we wouldn’t be surprised to see a follow on sale of that business.

But Hall has become a fan of the Beats music service, he writes, versus Pandora Media (P) and startup Spotify:

Prior to a few weeks ago we were mainly Spotify and Pandora listeners but had found that neither is great for music discovery. You need to know what you want on Spotify and Pandora stations get repetitive. Since this deal hit the press we have been using Beats Music and find the curated playlists and user presentation of those lists to be very useful for new music discovery. In fact, this writer has completely shifted off of the other two services. The only problem for us is the relatively high monthly price of $14.99/month vs. $9.99/month for Spotify – luckily AT&T offers a 3-month free trial.

Among the more negative reactions to the Beats deal today, BMO’s Bachman writes today he doesn’t see the value in it:

We are unclear about the branding strategy of Beats. Historically, Apple has acquired technologies and IP that would come under the Apple brand. However, Beats has an established brand name, particularly with its headphones. We believe that Apple could potentially leverage the Beats brand and installed base for the wearable category [...] We do not see clear value for the Beats acquisition. We don’t see a meaningful sustainable competitive advantage based on the IP of the headphones or Beats Music. In addition, we think the Beats subscriber base is relatively small.

Continuing with my recap of today’s explosion of Apple (AAPL) street prognostications, Morgan Stanley‘s Katy Huberty reiterated an Overweight rating this morning, and a $690 price target, focusing on the prospects for the company’s software and services, and, in particular, the App Store.

Huberty writes that overall monetization of services has been declining, but that App Store is a bright spot relative to iTunes:

In C1Q14, each of Apple’s credit card accounts spent on average $3.29, down 24% Y/Y. At a high level, this raises concerns about Apple’s ability to monetize the new base of emerging market customers [...] iTunes monetization is declining, while App Store monetization is stable and more recently growing. The iTunes decline is a function of users spending more time and money on services such as Spotify, Pandora, and Netflix, and less on songs and videos in iTunes. However, we are encouraged to see App Store monetization improve even as Apple’s user base growth shifts to emerging markets [...] We estimate Apple’s online services, including iTunes and App Stores, grew revenue by 21% to $9.6B in CY13, or 6% of total. Within that, the App Store accounted for 36%, or $3.4B of revenue, while iTunes accounted for the rest. We estimate App Store revenue will become 50%+ of online services mix by C4Q14 [...] Even without new services revenue streams, online services revenue growth should improve as the higher growth App Stores more than offset the decline in iTunes. In fact, at the current growth trajectory of each business, total online services revenue growth will accelerate from 9% in the recently reported quarter to low- to mid-teens exiting this year.

Here’s her chart of how growth may be lifted in coming quarters by services (click for larger image):

As a consequence, Apple’s overall operating profit margin can rise. That’s because at 49% for all services, and 46% for App Store (versus 15% for iTunes), services already makes up 63% of all Apple profit dollars, she believes.

“Our estimates suggest online services will become margin accretive in the current quarter, driven by higher App Store mix and without the help of any new services.”

Huberty, who wrote before Apple announced this afternoon it will buy Beats Electronics and Beats Music, for $3 billion, opined that there are multiple new ways for Apple to boost its services revenue in future. She outlines 3 such ways:

Streaming music: Every 1% Apple user base penetration = 8M users, $960M of revenue and $0.26 EPS Spotify reported 10M paying subscribers or 25% of its over 40M user base (MAU) in 56 markets globally as of May 2014 Pandora reported 76M active listeners mostly in the US at the end of April 2014

Mobile payments:Amazon generated $835M of advertising revenue with 200M accounts in 2013 according to eMarketer Facebook has 1.3B users (1Q14 MAU) and $8B of advertising revenue in LTM Using the range of ad dollars per user at Amazon and Facebook drives $3-$5B of potential revenue to Apple; Amazon charges $99 per year for Prime (up from $75 previously) Dropbox charges $10 per month for its Pro product Evernote charges $5 per month or $45 per year for its Premium product; Forrester forecasts $114B of commerce transactions on smartphones and tablets in the US in 2014, growing to $414B in 2018 Growth could be faster if mobile payment services reduce friction We assume Apple has 60% market share but some third-party data put its share as high as 80-90% Credit card companies are discussing lower “person-present” transaction fees and we believe Apple could take its typical 30% cut of the savings, which on the above math translates to $103M of revenue and $0.09 EPS;

iWatch App Store: Every 10M iWatches = $27M app revenue and $0.01 EPS. We assume Apple ships 32-58M iWatch in its first year We assume the average user spends an incremental $9 more per year on the App Store, half of their current $18 per year rate The above assumptions translate to $43-80M of revenue and $0.02-0.03 EPS next year.

Huberty’s comments on payments dovetail with a note today from Topeka Capital Markets’s Victor Anthony, who wrote that Apple could be a competitor to eBay‘s (EBAY) PayPal once Apple throws its hat into the ring. Her comments about an iWatch dovetail with comments from Barclays today about potential iWatch sales this year and next.

Among those opining, Topeka Capital Markets‘s Victor Anthony, who doesn’t follow the stock — that is left to his colleague Brian White — writes today that an entry into electronic payments by the company could have an impact on eBay‘s (EBAY) PayPal payments business.

Writes Anthony, who rates eBay a Hold, with a $60 target,

We do believe investors should watch Apple’s ambitions in payments and its impact to PayPal given its nearly 800 million credit cards through iTunes [...] Apple could go further and allow linking to checking accounts and ACH funding capability and have a fully competing offering to PayPal [...] If Apple gets serious about mobile payments, or an all-around payments solution, the growth curve and margin profile (stepped up investments) of eBay’s payments business (primarily Merchant Services/POS) could be at risk.

For one thing, the inclusion of a payments mechanism in the next iPhone via NFC “has the potential to disrupt PayPal’s own ambitions at the POS [point of sale],” he believes.

PayPal has relationships with about 20+ major retailers at the point of sale and the relationship with Discover (DFS) puts them in 7mm businesses by 2015,” he writes, “However, we believe traction at the POS is low today. The caveat here is adoption by retailers of NFC, which we believe is scant. However, Apple could change that.

Anthony notes the various tidbits that suggest Apple is poised for payments:

On the last earnings call, Apple’s CEO Tim Cook stated that “we now have almost 800mm iTunes accounts most of these with credit cards”. In an interview with the Wall Street Journal on 4/24/2014, Tim Cook stated that payments is “an area of interest to us”. A 1/24/2014 WSJ article stated that Eddy Cue, head of iTunes, had met with industry executives to discuss Apple’s interest in processing payments for physical goods and services on Apple devices. The same article stated that Apple moved long-time exec Jennifer Bailey into a role to build a payments business. We also understand that Tim Cook has been actively engaging with investors on the issue of payments. It is clear that Apple is moving towards offering a mobile payments solution for the purchase of physical goods and services which could incorporate the Touch ID fingerprint sensor technology, NFC [...] and the iBeacon location-sensor technology.

eBay shares today closed down $1.38, or 2.7%, at $50.39, while Apple stock closed off $1.62, or 0.3%, at $624.01.

Apple (AAPL) has announced it will purchase startups Beats Music, and a sister company, Beats Electronics, founded by Dr. Dre and music industry vet Jimmy Iovine, for $3 billion, including $2.6 billion up-front and $400 million that will vest over time, confirming weeks of speculation.

Apple shares are up 49 cents at $624.50, in late trading.

Dre and Iovine will join Apple, the company said.

Apple CEO Tim Cook remarked that “Music is such an important part of all of our lives and holds a special place within our hearts at Apple.”

“That’s why we have kept investing in music and are bringing together these extraordinary teams so we can continue to create the most innovative music products and services in the world.”

Apple iTunes guru Eddy Cue remarked that “Music is such an important part of Apple’s DNA and always will be,” adding that “The addition of Beats will make our music lineup even better, from free streaming with iTunes Radio to a world-class subscription service in Beats, and of course buying music from the iTunes Store as customers have loved to do for years.”

Cue and Cook posed for a picture for the release along with Dre and Iovine. It was not specified in the release what roles Iovine and Dre will take at Apple.

Nothing’s been announced, but the Street continues to reflect on the prospect of Apple (AAPL) buying Beats Electronics, makers of lifestyle headphones and other accessories, as rumors last week suggested.

UBS’s Steve Milunovich, who has a Buy rating on Apple shares, and a $585 price target, writing that he wants to know why Apple thinks this makes sense, but that he can think of three reasons it might:

The potential purchase of Beats Electronics for $3.2bn as discussed in the press could make sense given that (1) the purchase price is reasonable if Beats revenue is about $1.4bn with high margins; (2) Apple uses the music service to complement its mediocre success with iTunes Radio (see p3); and (3) headphones and their designers fit into the company’s wearable plans. Before formulating a strong opinion, it would be nice to hear Apple’s rationale.

Milunovich opines there may be a “cultural compatibility” matter here, that Beats backer Jimmy Iovine may share Apple’s focus on quality:

After listening to a 40-minute interview with Beats co-founder Jimmy Iovine, we think philosophical compatibility plays a role in a possible deal. Iovine said, “Everything we know is now wrong” about the music business years ago and agreed with Jobs’ view of how the industry would change. Beats started because there was not a listening complement to the iPod—Iovine thought the ear buds were poor. “Sound is the only conduit of emotion,” he explained in differentiating the Beats sound to competitors made by audio engineers. His focus on the user experience is similar to Apple’s emphasis on product experience vs the typical Android phone touting specs.

He’s also willing to grant that the brand may be worth acquiring:

Apple has not promoted the brand of a company it has acquired, but it does have sub- brands: iPod, iPhone, iPad, Mac. People use the product name knowing Apple makes them. “Beats by Apple” isn’t all that different. The Beats brand is attractive in its appeal to young people and to African-Americans. Although product quality can be debated, the image can’t: “Other headphones look like medical equipment,” Iovine said. Apple gained lifetime users by getting Macs into schools, which Beats might do for music.

On a less positive note, Toni Sacconaghi of Bernstein Research is more in the questioning mode of the other analysts from Friday’s reviews.

Sacconaghi, who has an Outperform rating on the shares, and a $615 price target, writes today that “We struggle with the rationale for this deal on several fronts.”

News articles indicate that the majority of the purchase price is for the audio business, but we suspect the key strategic reason is the music service. The audio business is likely to have high gross profit margins, but we are concerned that: 1) there is little differentiated technology versus other high end audio (headphone, speaker) vendors2; 2) audio gear is not a platform purchase that ties in with other iOS devices and services. It is interchangeable; 3) there is a definite “cool” factor driving Beats sales that may be ephemeral or may not continue with Apple as a large corporate owner, especially if Dr. Dre is not as involved. On the Beats Music side, we also struggle with why Apple has to acquire this business versus competing with it directly with a subscription streaming option on iTunes Radio. Apple would seemingly have significant advantages versus Beats Music including vastly deeper pockets, ~800M iTunes accounts with most linked to credit cards, an iOS installed base of ~500M devices, large music libraries and iTunes availability in 100+ countries (although iTunes Radio is currently only available in the U.S. and Australia).

He thinks maybe it’s because iTunes is searching for growth:

We estimated last month that iTunes revenue grew 8% in FY13 and will grow 4% in FY14, but this estimate may already be too optimistic. In Apple’s most recent 10-Q, the company said it saw a YoY decline in digital music sales. Billboard magazine cites music label executives as saying that iTunes music downloads have seen >15% declines. It is also unclear how much traction iTunes Radio is having in generating revenue. The same Billboard article indicates that only 1-2% of iTunes Radio listeners are clicking to buy songs. Apple has not mentioned iTunes Radio on their two most recent conference calls, and in February, Pandora said the impact from iTunes radio was only “modest”.

Like some others, Sacconaghi thinks Apple should have other priorities for its M&A:

Apple’s decision to augment its music business through acquisition makes less sense to us than looking to buy content to augment Apple TV and make it a more complete over the top video offering, a la Netflix. The streaming video market offers much more attractive growth and a larger total addressable market. Apple TV has grown its reach enough, with ~20M boxes sold, for Apple to stop referring to it as a “hobby” and instead think of the business as more core offering. Tim Cook said on Apple’s April earnings call, “the reason that I stripped off the hobby label is that when you look at the sales of the Apple TV box itself, and you look at content that was bought directly off of Apple TV for 2013, that number was over $1 billion. And so it didn’t feel right to me to refer to something that’s over $1 billion as a hobby. Also, from an investment point of view, we continue to make the product better and better, and so it doesn’t feel right from that point of view either.”

Shares of online streaming radio music purveyors Pandora Media (P) are up 81 cents, or 3.6%, at $23.43, after MKM Partners’s Rob Sanderson this morning raised his rating on the shares to Buy from Neutral, although he cut his price target to $32 from $39, writing that the company may be able to turn its high content costs into a strength, and that Apple (AAPL) has failed to compete effectively with its own “iTunes Radio” service.

Sanderson raised his estimates for this year to $916.4 million and 17 cents per share in profit from a prior $882 million and 15 cents. For next year, he sees $1.14 billion in revenue, up from his prior $1.129 billion estimate, and sticks with an EPS view of 59 cents a share.

Pandora is proving more “sticky” than Sanderson thought, and it looks like Internet is going to continue to take a chunk of total radio listening:

While we still think the environment for Internet music services is likely to become more competitive in the future, we have better appreciation for the stickiness of P’s position. More important, as device connectivity becomes more ubiquitous (especially in autos), the Internet will become the primary delivery mechanism for music services displacing FM- radio. In this scenario, broadcast radio would still have the majority of radio audience by 2020. This example illustrates that while there may be increasing competition for music streaming services, this shift is coming at the expense of FM-radio listening and there is a very long way to go.

Here’s his model of Pandora and Internet listening overall versus Sirius XM (SIRI) and all broadcast:

Sanderson thinks the company can get higher ad “loads” on its properties, and higher prices, or “CPM,” which means it doesn’t have to spend as much, potentially:

There are advertising/subscription and desktop/mobile considerations, but we reduce this to a single RPM assumption in our framework. This is effectively a proxy for mobile advertising monetization and is a function of ad load and pricing. Ad load is currently low, less than 2 mins per hour on average but has been increasing. The company can double ad load and still be well below ad-cluttered FM-radio which has 12-13 mins per hour of advertising. The company continues to improve its ability to target. This makes P a more efficient marketing platform for advertisers and for consumers. Fewer impressions delivered to the most receptive ears can maximize effectiveness with higher CPMs but potentially lower overall spending. Sensitivity: A $5 change to RPM is about $0.30 per share in earnings power on 2017 and $0.40 per share on 2020.

He also thinks Apple has made much of a dent, writing simply “Apple has not executed well on iTunes Radio and the iTunes music franchise is falling further into the realm of irrelevance.”

In conclusion, Sanderson’s call is a mix of confidence in the story but also bottom-fishing a beaten-down stock (Pandora is off 12% this year and down 42% from its 52-week high):

After proving our earlier concerns on competition and ability to scale ad monetization wrong, we began to see significant earnings power in P’s model but could not justify the stock on valuation. The severe valuation collapse among mobile, local, social stocks has changed this and is creating a buying opportunity. After several adjustments to our earnings power framework and assuming a higher discount rate of 30% per year (see page 4), we are establishing a 12-month price objective of $32 per share (prior fair value estimate was $39).

Shares of Nimble Storage (NMBL) are up $2.83, or almost 14%, at $23.42 after Needham & Co.’s Richard Kugele raised his rating on the shares to Strong Buy from Buy, but cut his target to $35 from $62, writing that “While today’s market may shirk high-multiple tech names, not all were created equal, in our view.”

“We think that companies like NMBL, which we believe can grow 50%+ for the next several years, warrant a premium multiple on their growth potential.”

“While the magnitude of that premium has arguably fallen since the peak of “risk-on” for high-growth names, we believe it nonetheless justifies a 7x EV/Sales multiple.”

Among other upgrades today, shares of Twitter (TWTR) are up $1, or 3.2%, at $33.05, after SunTrust Robinson Humphrey’s Rob Peck this morning raised his rating on the shares to Buy from Neutral, with a $45 price target, writing that it doesn’t have to have the fastest growth to perform as a stock.

“One of the common comments we hear from investors is ‘with Twitter’s MAU growth slowing, Twitter will never be as big as Facebook‘ (FB). Based on our calculations, we believe one can justify buying the stock at these levels solely predicated on Twitter continuing to narrow the 50% monetization gap to Facebook, while still assuming user growth deceleration.”

Meantime, MKM Partners’s Rob Sanderson cut his price targets on several Internet names, including Twitter but also Netflix (NFLX), Yelp (YELP), Pandora Media (P), and Angie’s List (ANGI), writing that there is “no change in conviction” about their bright futures — he rates all of them a Buy — but that “As investor appetite for growth expanded in 2013, the implied discount rate in our valuation framework dropped from 30% to 25% for many of our stocks. In our new targets we are now using 30% for NFLX and P, 35% for TWTR and YELP and we use 60% for ANGI.”

Sanderson cut Twitter to $55 from $72, cut Yelp to $86 from $110, cut Netflix to $435 from $440, and cut Angi to $16 from $20.

Analysts continued to ponder reports last week that Apple (AAPL) is poised to spend $3.2 billion buying Beats Electronics, maker of the lifestyle headphones and such. Toni Sacconaghi with Bernstein Research this morning reiterated an Outperform rating on the shares, and a $615 price target, writing that ”We struggle with the rationale for this deal on several fronts.”

“The fact that Apple is considering acquiring Beats may reflect the struggles the company is having with iTunes. We have previously estimated that iTunes is essentially ex-growth now3 and unlikely to be a contributor to growth going forward.

Bloomberg’s Peter Burrowspenned an item over the weekend saying Apple will be more likely to acquire, citing remarks by Gene Munster of Piper Jaffray. The article mentions as possible acquisition targets for Apple Yelp, payment startups Square, and Twitter.

In other Apple news, DigiTimes’s Aaron Lee and Adam Hwangthis morning report that Apple’s shipments of MacBook laptops are expected to rise faster this quarter than the overall PC market, at perhaps 28.6%, citing unnamed parties in the Taiwan supply chain. The authors write their sources suggest MacBook shipments this year could be 14 million versus 10 million last year.”

Apple shares are up $3.68, or 0.6%, at $589.22.

Cisco Systems (CSCO) reports fiscal Q3 results this Wednesday, May 14th, after the closing bell, and analysts are tuning up their models. The Street is modeling $11.36 billion in revenue and 48 cents EPS.

Brian White with Cantor Fitzgerald reiterates a Buy rating on Cisco, and a $27.50 price target, writing that “our model suggests that Cisco’s profit cycle bottomed out in 3Q:FY14 (April), and we expect major new platform initiatives to begin contributing more meaningfully to revenue over the next couple of quarters.” However, he’s modeling just $11.25 billion in revenue and 47 cents EPS, though he thinks Cisco may end up beating that.

Stifel Nicolaus’s Sanjiv Wadhwani reiterates a Buy rating as well, and a $25 price target, writing that “The main conclusion from our survey of 30 value-added resellers (VARs) and distributors in the United States and Europe along with supply chain read-through is that Cisco will report an inline April quarter.”

ISI Group’s Brian Marshall this evening cut his rating on shares of Apple (AAPL) to Buy from Strong Buy, while raising his price target to $675 from $600, writing that the 15% rise in the shares since early April means “upside potential is somewhat reduced with the stock now at ~$600.

Marshall notes the Apple ecosystem is proving “stickier” than he thought:

While we have always believed AAPL’s ecosystem (e.g., iTunes, App Store, iOS, OS X, iCloud, etc.) was highly “sticky” for existing users, we are pleasantly surprised to see AAPL’s user base expanding at a healthy pace (e.g., ~60mil new users in ~6mo, ~1/2 of iPhone buyers new to iPhone, ~2/3 of iPad buyers new to iPad, etc.). Importantly, iPhone 5S is also doing very well in emerging markets where per capital income levels are much lower than in AAPL’s more established markets. This provides us incremental confidence that next generation iPhones / iPads can help continue growing the ecosystem (vs. simply serving as a refresh for the installed base).

Can the stock get back to $700, he wonders:

Possible to return to 2012 all-time highs >$700/share? In our view, ecosystem growth and size (i.e., installed base) are the most important metrics for the long-term potential of AAPL. We believe $700+/share could be a possibility in CY15 if AAPL can offer greater evidence/visibility on the rapid expansion of its ecosystem (vs. simply becoming a developed market upgrade cycle story). Until we see the bill-of-materials (i.e., BOM) of the upcoming iPhone 6 which will be the most important financial lever for AAPL in the near-term, we believe it’s prudent to move to a BUY rating at the current ~$600 level.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.